Floating-rate bonds are characterised by the fact that their interest rate is adjusted to
current interest-rate levels on a regular basis (every three, six or twelve months). The
issuer determines the reference rate and in some cases a spread ahead of time and notifies
investors of these conditions. The creditworthiness is also a key factor
in determining the spread. The lower the rating, the larger the spread. The terms and conditions
of the bond issue may provide for the spread to be adjusted in the event of a change in the
issuer's credit rating.
Floaters come in the following variations:
Bond with a minimum interest rate (floor floater)
The floating interest rate cannot fall below a certain minimum (floor). This ensures that
investors receive a minimum interest rate.
Bond with a maximum interest rate (capped floater)
Floating-rate bonds whose interest rate is determined by the difference between a
fixed rate and a reference rate. When the reference rate rises, the coupon of the reverse
floater goes down and vice versa (e.g. 10% minus 3-month LIBOR). The investor's interest
income increases when the reference rate drops.